(1 of )This artwork by Matt Wuerker relates to the impact of deregulation and the subprime mortgage crisis on the stock market.

(2 of )This artwork by Matt Wuerker relates to the impact of deregulation and the subprime mortgage crisis on the stock market.

(3 of )Joe Nocera

Nocera: Lessons not learned at key moments

JOE NOCERA

BY JOE NOCERA | August 27, 2014

The death of Fernand St Germain last week, at the age of 86, got me thinking about the financial calamity that he was long associated with: the savings and loan crisis of the late 1980s. There are things it could have — and should have — taught us as we spiraled toward the financial crisis less than two decades later.

“Freddie” St Germain was the sort of congressman you don’t see much anymore: the lovable rogue, a backslapping, deal-making legislator who saw nothing particularly wrong with taking advantage of his position to feather his own nest. As the New York Times pointed out in its obituary, he liked to joke that he didn’t put a period after “St” because he was hardly a saint. Entering Congress in 1961, when he was 32 years old, he steadily climbed the seniority ladder until he was the chairman of the House Committee on Banking, Finance and Urban Affairs in 1981.

It was a terrible time for the nation’s 4,600 or so S&Ls. Inflation was raging, and interest rates spiked as high as 21.5 percent. But the interest rate that S&Ls could offer their depositors was fixed at 5.25 percent, an amount established by government regulation. As consumers realized that the value of their deposits was being eroded by inflation, they began to move their money to a newfangled financial device being offered by mutual fund companies: the money market fund, which paid competitive rates of interest.

It was Congress’ view — and it was certainly St Germain’s view — that the S&L industry was vital to the American dream of homeownership. Indeed, back then, the only loans the industry was allowed to make were mortgages. Thus, in 1982, Congress passed the Garn-St Germain Depository Institutions Act — which St Germain wrote with Sen. Edwin “Jake” Garn, R-Utah — which essentially deregulated the industry, allowing S&Ls not only to pay market interest rates but to make loans far afield from home mortgages.

The idea was that S&Ls needed to be able to make more profitable loans since they were going to be paying much higher interest rates to gain deposits. What nobody seemed to realize was that financial deregulation was bound to have unintended consequences. S&Ls went from being the most cautious of financial institutions to the most heedless. S&L operators dove into all kinds of exotic areas. By the late 1980s, it had all come a cropper; ultimately more than 1,000 S&Ls — one out of every three still operating in 1988 — went under. The industry’s collapse cost the taxpayers nearly $125 billion.

In some ways, the legislators who deregulated the S&L industry felt that they had no choice — if they didn’t act, the S&Ls would have been in terrible trouble, just of a different kind. Seventeen years later, when Congress repealed the Glass-Steagall Act —- thus deregulating the entire financial services industry — it didn’t have that excuse. The drive to abolish Glass-Steagall was ideologically inspired, the core belief being that the market would keep the industry honest. But the S&L crisis had proved that wasn’t true.

Rather, bankers were only too happy to privatize profits and socialize losses. During the S&L crisis, bankers fueled an unsustainable commercial real estate bubble, sold bonds to customers that turned out to be worthless and, generally, used shoddy business practices to enrich themselves. In the years leading up to the 2008 financial crisis, bankers handed out mortgages to millions of people who lacked the ability to repay them and then bundled those mortgages into toxic subprime mortgage bonds. It was just a variation on a theme.

There is another lesson from the S&L crisis. In its aftermath, there were somewhere around 1,100 prosecutions, the most famous of which was that of Charles Keating, the chairman of the Lincoln Savings and Loan Association, an institution that cost the government $3.4 billion when it collapsed. A few years ago, I asked someone who had been involved in prosecuting S&L operators why the government had been so intent on putting them in prison. “Because the country demanded it,” he said.

In the wake of the financial crisis, the Department of Justice also set up a task force to root out the wrongdoing that led to the financial crisis. But it has mostly been a joke. The prosecutions have been mostly small-time stuff: homeowners who lied on liar loans, for instance. Meanwhile, not one single employee of Countrywide Financial has been prosecuted, even though Countrywide loans were at the very heart of the financial crisis.

Earlier this week, Bank of America agreed to pay $16.65 billion to settle a handful of government investigations. Bank of America, of course, bought Countrywide in 2008, and the huge sum it was paying was the government’s way of showing that it was tough on financial crime after all. But it’s not the same as prosecuting those responsible. After all, the country is still demanding it.